Approaching Stall Speed

We favor high yield bonds and natural resource stocks as inflation still shows persistence, earnings expectations deteriorate and worries mount over a stalling U.S. economy.


Banking system concerns of a month ago have largely faded following liquidity support from the Federal Reserve and the passage of time without further failures – though not without consequence. The extension of credit from smaller regional banks is likely to decline (see chart below), and while brief, the period of instability adds to preexisting angst among businesses and consumers regarding the likelihood of recession. Despite this backdrop of softening growth expectations, the abating of systemic concerns drove gains in equity markets to levels approaching the prior highs for the year.

Inflation readings in March continued to moderate with headline Consumer Price Index (CPI) declining to 5.1% from 6.0%, but core inflation measures followed most closely by the Fed have failed to show the same degree of improvement. The core CPI reading for March (5.6%) actually inched up slightly from February as we await the expected upcoming turn lower in the data from areas like housing. The Fed and European Central Bank (ECB) both moved rates higher in the past month, with the markets pricing in just one more move for the Fed, while the ECB is expected to continue hiking until mid-year. Increasing risk of a mild recession in the U.S. is likely to limit the magnitude of the Fed’s rate hike cycle to perhaps one or two more moves, though we expect a longer plateau at the terminal rate than current market expectations (which show the Fed cutting rates before the end of the year).

Gains in equities this year against a backdrop of falling earnings expectations have led to valuations that provide limited upside in the base case. With our view that any possible recession in the U.S. will be shallow and short-lived, we see better risk/reward in high yield bonds than in U.S. equities at current pricing levels.